Citi and Bank of America "Encouraged" to Get More Capital as Result of Stress Tests

Ah, in Lake Woebegone, all the women are beautiful and all the children are above average. And in the stress tests, no one fails, they just need to get more equity, preferably not from Uncle Sam, but he is always there to help his best bankster buddies.

Recall many observers, including yours truly, deemed the Team Obama stress tests to be more than a tad permissive. Their supposed downside scenario is coming to look more and more like a middle of the road outcome. Moreover, the banks ran the tests themselves (!) using their own pricing and risk models, and the focus was on loans, when many types of structured credits are more sensitive to increasing default rates.

But even with these industry-coddling approaches, Citi and BofA, both of which have large securities operations, appear to be coming up a tad short. This is either a sign that they are in as bad shape as we suspected (ie, even with the lax stress tests they didn’t look too hot) or the criticism of the tests made the powers that be realize that giving the big banks a pass, particularly if they were to get in trouble not too far down the road (as in the next year) would completely undermine the Treasury’s credibility. Treasury said that the interpretation of the results would be more stringent in light of worsening economic conditions, so perhaps they did recalibrate their grades.

From the Wall Street Journal:

Regulators have told Bank of America Corp. and Citigroup Inc. that the banks may need to raise more capital based on early results of the government’s so-called stress tests of lenders, according to people familiar with the situation.

The capital shortfall amounts to billions of dollars at Bank of America, based in Charlotte, N.C., people familiar with the bank said.

Executives at both banks are objecting to the preliminary findings….The two banks are planning to respond with detailed rebuttals, these people said, with Bank of America’s appeal expected by Tuesday.

Yves here. I grew up when regulators were feared. This idea that you can negotiate with them is perverse, particularly when these tests went on for weeks. Back to the story:

The findings suggest that government officials are using the stress tests to send a tough message to struggling banks. Bank of America and Citigroup have been the highest-profile problem children in recent months, but it is unlikely that they are the only banks the Federal Reserve has determined might need more capital.

Industry analysts and investors predict that some regional banks, especially those with big portfolios of commercial real-estate loans, likely fared poorly on the stress tests. Analysts consider Regions Financial Corp., Fifth Third Bancorp and Wells Fargo & Co. to be among the leading contenders for more capital….

Government officials say their meetings about the stress tests with bank executives over the past few days conveyed preliminary results and that discussions were expected to continue this week about specific findings. They also say that banks directed to raise more capital shouldn’t be viewed as insolvent.

Instead, the capital is intended to cushion the banks against potential future losses under dire economic conditions. Federal officials say they won’t allow any of the top 19 banks to fail.

Still, it is unclear how flexible the government will be about adjusting the results, especially as banks plead their cases individually. Banks have until the middle of this week to lodge their formal responses to the tests. Bankers expect that will set the stage for several days of intense negotiations between the banks and their examiners….

Bank of America’s capital hole as measured by the regulators is in the billions…It isn’t clear how big a capital deficit Citigroup faces….

Raising capital in the current environment is nearly impossible for troubled financial institutions…

Some bank executives have said that even after meeting with Fed examiners on Friday, they still don’t understand details of the government’s methodology for conducting the tests…

One question is how the government is projecting banks’ revenue streams through 2010. Some bankers are optimistic that the Fed will use their first-quarter numbers to predict their performance for the next two years.

That could inflate the banks’ earning potentials — and thus their capital cushions — because many of the companies had strong first-quarter performances.

Analysts, investors and most executives say those results probably aren’t sustainable.

Now I will admit I said if the tests fingered Fifth Third and not Citi, something was clearly wrong. So if Citi is required to secure more equity, the tests pass at least a minimal threshold of credibility.

But let us not kid ourselves as to what these results mean. Unless these banks pull a rabbit out of the hat, they will be back at the government trough for more funds.

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18 comments

  1. David

    This article is ridiculous. All it says is that it is “in the billions”. Of course it is in the billions. What else would it be, in the millions, the thousands? I guess it could have been in the trillions but that would be pretty absurd.

    The banks are going to appeal. What a farce all of this is!

    And how is the Treasury going to get more capital to put into banks without asking congress? Are they going to borrow the money from the Fed? More shenanigans, more foot dragging, more denial.

  2. Aiden

    Why don’t they just lower the capital requirements for these 19 large institiutions. These are not japan’s zombie banks, they are generating enough loans to break even, this is despite their huge need to build reserves. After provisions and excluding the gain on the debt, both Bank of America and Wells Fargo broker even, that shows that even with astronomical mortgage and other losses from Merrill and Wacky Bank these banks can earn their way out of the down cycle. If JP Morgan or US Bank is forced to raise equity, than these stress tests are a total joke and are not a fair representation of bank solvency. Forbearance is what is needed here, not a waste of both private investor and taxpayer dollars.

  3. xgene

    Given the actions of Paulson & Bernanke with regard to the acquisition of Merrill Lynch by BofA, I would expect that no CEO or Board is taking instruction from regulators without a serious look at the implications and possible alternatives.

    We cannot trust either set of individuals or institutions to look out for shareholder or taxpayer interests and it is unrealistic to expect them to trust each other.

    A sad state of affairs all around.

  4. Yves Smith

    Aiden,

    You are falling into the John Hempton trap of viewing Citi and BofA as traditional banks. Citi in particular has huge capital markets operations. Even JP Morgan, which looks to be in better shape than the rest, is more a trading firm than a retail bank (oh, and the margins on big corporate banking are lousy, it’s middle market and small business banking that have better spreads).

    So the idea that they can just earn their way out with big capital markets operations is dangerous. Those businesses ran with way way too much leverage in the good years, and they need larger equity cushions. Moreover, the no risk fee activity is diminished these days.

    And these banks are booking loans that have nice spreads due to super low interest rates. Presumably they are hedging the risk, either by having them float over a benchmark or hedging. Nevertheless, what happens when the Fed has to raise short rates in a year or two? Spread heaven is not a God given permanent state.

  5. john bougearel

    Every day there is a new leak. Why even set a May 4 “stress-test” release date. The leaks themselves are frustrating for those of us who appreciate knowing when and where a curve ball is going to be released so we can hedge it.

    I can’t wait until this crap is over. How long oh Lord, a decade or more? :-)

    But as for the stress-tests passing minimum credibility, well, perhaps the bar was set too low given that the banksters got to do all the projections:

    “Each participating firm was instructed to project potential losses on its loan, investment, and trading securities portfolios, including off-balance sheet commitments and contingent liabilities and exposures over the two-year horizon beginning with year-end 2008 financial statement data.”

  6. Chindit13

    Re: Yves point about “spread heaven” not being a permanent state.

    Look at the scale of the loans/refi’s done by the likes of BAC and WFC at 4.7% in the last quarter.

    Hedging? Great. When and how? Are they assuming an orderly retreat in rates that will give everyone time to adjust and match book? If rates start to go, the move could be breathtaking given the current state of debt and fear. Nobody can clap with one hand. Remember “portfolio insurance”? It’s there until you need it.

  7. slugworks

    Aiden: “These are not japan’s zombie banks..”

    Quite right – these are America’s Zombie banks. And with the way things are going, we’re going to give Japan a run for their (fictious) money.

    From Alex Kerr’s Dogs and Demons:

    “During much of the past half century, money poured into the Tokyo Stock Exchange, driving stocks relentlessly upward. After decades in this hothouse atmosphere, Japan’s financial community came to believe in the “magic of assets”: assets would always rise in value, especially when calculated by a technique, dear to [Ministry of Finance]’s heart, known as “book value accounting.” According to this system, owners of stocks, bonds, and property do not need to assess their holdings at market value. Instead, balance sheets show stock at the price purchased – the stock you bought at 100 seven years ago, although now worth 200, still appears on the books at 100.

    This is a complete fiction, and it spawned a concept known as “latent profits,”, which is the difference between purchase value and current value. The concept of “latent losses” did not exist.. {Page 84}

    This new paradigm of capitalism once appeared to have triumphed over old-fashioned Western values such as the law of supply and demand. There was just one little flaw. As Nigel Holloway and Rober Zielinski wrote back in 1991, “The competitive advantages that Japanese companies gain from their stock market depend on a single factor: share prices must go up.” The Ministry of Finance patched together an intricate machine to support this market: stocks that yielded no dividends, real estate that produced no cash flow, debts that companies never needed to repay, and balance sheets that legally hid losses and liabilities. In this Market, no Japanese company could ever go wrong. It was the envy of the developed world.

    It was a powerhouse, but it also was a Ponzi scheme.. {Page 87}

    Japan and the US do not align completely – based on Alex Kerr's book I'd say the current American crisis appears to be far more open and better reported (at least by the independent voices like Yves) than the Japanese banking crisis was. But the main thrust of it – the banks run up huge, imprudent debts, cover them up with the aid of the government, and bail them out using taxpayer dollars (either directly or via 'lending' with crap collateral) – is the same. Same sort of crisis, same corrupt policy response, same likely outcome – stagnation and prolonged recession at best, depression and systemic crash at worse.

    Aiden: "..earn their way out of the down cycle..".

    Nonsense. This same theory was floated during the S&L crisis, and it's just as wrong now as it was then – it did not work. The fraudent S&Ls just got larger, increasing their crap lending and growing as fast as possible to keep the Ponzi moving.

    Aiden: "Forbearance is what is needed here,.."

    Nonsense.

    The history of the S&L crisis demonstrates conclusively that the more forebearance we give failed, compromised, criminal-run banks, the more they will ultimately cost the taxpayer to resolve when they fail. Go re-read Alex Black – time is money. The longer these debt-choked wrecks continue to exist, the greater the inevitable crash.

    If they are solid institutions, then they are healthy enough to return TARP funds and trade their cash & t-bills in for the crap collateral they put up at the alphabet windows.

  8. Doc Holiday

    This garbage from Citi seems to be on topic again:

    “If the current level of credit support was considered insufficient to cover projected losses, the security was written down to fair value with a corresponding “other than temporary impairment” charge, in accordance with accounting guidelines, equal to the difference between book and market value.”

    Citi and all these other toxic waste depositories have Treasury, FASB, SEC, DOJ, FTC and a host of other corrupted government entities to thank for on-going false and misleading information, fraud, conspiracy and collusion, e.g:

    Can PCAOB Fair-Value Guidance Calm Jittery Auditors?Under previous auditing rules, auditors must obtain a grasp of how their client companies determine fair value measurements. Contingent on whether the auditor finds a significant enough risk of material misstatement to go forward, the auditor should test the entity's mark-to-market measurements.

    But there's "a wide range of possible fair value measurements, from relatively simple to complex," the board notes. Also, there are various levels of risk that a material misstatement can stem from companies' processes for measuring fair values. As a result "the auditor's planned audit procedures can vary significantly in nature, timing, and extent," according to the new alert.

    Among other things, the PCAOB notes, auditors can test management's major assumptions and companies' valuation models and their underlying data. Auditors can also develop independent fair-value estimates to corroborate what management says. Or they can review later events and transactions to gauge the effectiveness of their clients' methods.

    (>>)*> This Stress Test Crap brings up the question as to how banks will report their falsified reporting to shareholders and obviously The SEC — screw this "Bogus Stress Test" that Timmy designed for his PR/Dog und pony stunt, what about accounting truth and what about falsified accounting and fraud … huh, huh, WTF about that?

    {{>>}}>* Dear Lord, We pray that this garbage bag specimen, I mean bagmen are struck down by your most powerful wrath melted like that nasty and highly evil and corrupt crapbag witch in The Wizard of OzAmen

  9. Anonymous Jones

    One of the main reasons to cite when claiming this is merely theater is the impotent dictate that these “stressed” banks raise capital from “private sources.” These banks, as the administration (and anyone who has his/her head a few inches out of his/her ass) knows, could not have raised capital six months ago, let alone after a “stress test” deemed them on the verge of collapse upon any sort of decline in the overall economy. Who exactly is this supposed to fool? Yes, yes, I know, many people are being fooled now, but look, hindsight is 20-20; a brilliant strategist foresees how something will be viewed by the masses in hindsight (he/she does not try to needlessly massage viewpoints ante-crisis). This is embarrassing any way you cut it. It’s embarrassing to those like us who see the farce for what it is now (prior to the release of the “stress tests”); and it will surely be embarrassing to any analyst ex post facto. It’s a sad day for anyone who believed that Obama might just begin to clip at the edges of corralling the disgusting grip of the plutocracy in this country. A sad day indeed.

  10. Anonymous Jones

    It is embarrassing to comment twice, but I should probably add that I felt the same way during the march to the Iraq War. It was obvious that the WMD charges were trumped up (the experts actually on the ground in Iraq said as much…and pretty forcefully). What held me so rapt at the time was wondering what sort of plan the Bush administration had once it became clear that their WMD charges/al-Qaeda ties arguments were BS from the beginning. What wasted time! They had no plan! They simply never thought more than one step ahead. I was sure they would plant something, or at least have some sort of defensible argument about a good faith error. No. Nothing of the sort.

    I wish I could play poker with these fellows.

  11. elartistamadridista

    Regarding the Q1 numbers, today Deutsche Bank posted good results, so that could indicate that US banks results are not so phony, after all.
    Then again, it is worth noting that DB was a prominent name in AIG´s infamous list of counterparties. Perhaps they received some mana from the american taxpayer this way.

  12. Brick

    There appears to be an assumption that this recession is all about the banks, but it appears to me to have a number of key stages. First you have an Asset/House bubble bursting which is still going on, next you have the bank leverage and risk management problems, the third stage is about the real economy. Unhealthy banks can exacerbate problems but healthy banks will not really solve anything for the real economy unless they want to give away money. An unemployed person can not spend money regardless of the state of banks, and the fact that people can not use their houses as an ATM will constrain the economy. More than 10 percent of consumer spending was financed by equity withdrawal and until consumer debt is paid down consumer spending is unlikely to pick up.

    Yes banks can make bigger profits on their slice of the lending pie, but that pie is shrinking and there is still the risk that existing loan losses can swamp those bigger profits, especially once those commercial real estate loans really start to default. If Citi and BofA do not need more capital after the stress test nobody will have any faith in the stress tests. The whole point of the stress tests was to convince investors that the banks are viable and I cannot see it working.

    Unless the Treasury literally pumps huge sums of money (trillions) into the banks so it becomes obvious they can survive nobody is going to have faith. One off profits, accounting rule changes , tier 3 assets all mean that the truth is so obscured that whether the stress test is valid or not for individual banks it will not be trusted.

    I expect one or two banks to need to raise a couple of billion pounds as a result of the test. Enough to get investors piling back in, but once a bank which has passed the stress test needs more money after that then we could be in for a very serious market melt down as it becomes obvious to everyone that the tests were not rigorous enough.

  13. frances snoot

    Max Keiser’s site has an entry regarding the Italian city of Milan suing JPMorgan and Deutsche Bank for derivatives fraud. What stress will this put on the Americans? Is there any chance ANYONE will see justice from this? If FRAUD is inherent, why are we bailing these guys out and not prosecuting them? Is that the next wave?

  14. frances snoot

    Will Obama come in with the IMF (messiah in the temple with the money changers) and destroy the capitalists for elite interests? Is this the ‘new capitalism’ the media is shilling for…Celente calls it good old facism.

  15. Doc Holiday

    Milan Police Seize UBS, JPMorgan, Deutsche Bank FundsMilan’s financial police seized 476 million euros ($620 million) of assets belonging to UBS AG, Deutsche Bank AG, JPMorgan Chase & Co. and Depfa Bank Plc amid a probe into alleged fraud linked to the sale of derivatives.

    The police froze the banks’ stakes in Italian companies, real estate assets and accounts, the financial police said in a statement today. The assets seized yesterday also include those of an ex-municipality official and a consultant, the police said.

    The City of Milan is suing the four banks after it lost money on derivatives it bought from the lenders in 2005. The securities swapped a fixed rate of interest on 1.7 billion euros of bonds for a variable rate that was losing the city 298 million euros as of June. Milan is among about 600 Italian municipalities that took out 1,000 derivatives contracts worth 35.5 billion euros in all, the Treasury said.

    “Milan is an important case because it can be used as an example by others,” said Alfonso Scarano, who is heading a study into the trades by AIAF, a group representing Italian financial analysts. “This is a unique time for borrowers to shed light on their potential losses and renegotiate contracts” to take advantage of interest rates that have fallen to record lows. AIAF will next week testify before the Italian Senate’s inquiry into the cities’ use of derivatives contracts.

    >> They need to arrest >>>all<<<< these pirates and go over the books until the truth is reveled — even if takes 5 years!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!hkby7-i8724rv897tb987tIUytitybiyti6TBIUYFIWETYERYERIUYE4OUYERYTG

    Full Disclosure: The Author is pounding on the keyboard but happy that action like this has started!

  16. Martin

    I posted this yesterday in links, but since it seemed much more germane to this article, I thought I’d do a repost, hope that’s not too annoying. In light of the bargaining apparently going on, it seems to me more likely that B of A is actively cutting credit to improve their position for the stress tests. I’d love to hear if anyone else thinks there is any merit to this argument. Could they also be cutting business lines of credit as well, posing new risks going forward directly linked to the stress test outcomes?

    From yesterday’s comments:
    My credit limit was just cut from $17,600 to $9,000 on an MBNA card (FIA card services). It used to be Wachovia branded but Wachovia cut it’s cord on it last month and I’m going to get a rebranded card in the mail. When I called to ask why they cut the limit they said it was due to low usage ($2000 max over past 12 months)

    I saw the following quote in the Treasury “whitepaper”:

    “The BHCs also were asked to project losses on loans that could be drawn down from unused credit commitments in place as of year-end 2008…” (http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090424a1.pdf pg 8)

    I made me curious as to whether the credit reduction (which my card issuer also said they haven’t mailed a notification on yet but would be “soon”) was part of a mitigation effort by B of A due to the results of the stress test. Since I haven’t been mailed the notification (which I also thought was illegal), I assume the reduction was very recently, but I can’t say if it was general credit conditions, related to the Wachovia change-over or something else to cause the reduction. All I know for sure is it wasn’t something related to my personal credit as there have been only positive changes to that in the past 3+ years.

  17. Elijah

    How does loaning money to an insolvent bank solve this problem? It does allow them to meet cash flows in the near term, but it doesn’t erase their massive losses.

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